Specified domestic entities must now report under sec. 6038D.

• Author: Schreiber, Sally P.

The IRS issued final regulations requiring specified domestic entities to report specified foreign financial assets in which they have interests (T.D. 9752). The rules generally apply to tax years beginning after Dec. 31,2015.

Sec. 6038D, enacted as part of the Foreign Account Tax Compliance Act (FATCA), requires individuals to report interests in specified foreign financial assets (SFFAs) when filing their federal income tax returns for tax years beginning after March 18, 2010, using Form 8938, Statement of Specified Foreign Financial Assets.

Until now, the requirement to report SFFAs applied only to individuals, but the IRS is also authorized to apply the reporting requirement to any domestic entity that is formed or availed of principally to avoid reporting (a specified domestic entity). In 2011, the IRS issued Prop. Regs. Sec. 1.6038D-6, under which specified domestic entities would be required to report SFFAs. The IRS adopted the proposed regulations with only a few changes.

The most significant change is the elimination of the "principal purpose" test. Prop. Regs. Sec. 1.6038D-6(b) (l)(iii) provided that a corporation or partnership would be treated as formed or availed of for purposes of holding, directly or indirectly, SFFAs if either: (1) at least 50% of the corporation or partnership s gross income or assets are passive; or (2) at least 10% of the corporation or partnerships gross income or assets are passive and the corporation or partnership is formed or availed of by a specified individual with a principal purpose of avoiding Sec. 6038D (the principal purpose test).

"Principal purpose" in turn is determined by all the facts and circumstances. Because the IRS has decided that the 50% passive income or assets test is adequate to deter abuse and that taxpayers should be allowed to determine their reporting requirements by relying on objective, rather than subjective, criteria, the final regulations eliminate the principal purpose test.

Another significant change to the proposed regulations is to the definition of passive income. The final rules align this definition with the definition of passive income under Sec. 1472, because the definitions under both Code sections serve a similar function, which is to identify entities that have a high risk of being used for tax evasion and to reduce compliance burdens for active entities. The final regulations (1) clarify that "dividends" include substitute dividends and expand "interest" to...